Stress tests

As the mortgage industry gears up for the advent of the mortgage market review (MMR) rules, a survey suggests that many advisers and lenders are concerned about their possible impact. The research, conducted by the Intermediary Mortgage Lenders Association (Imla) shows that 64 per cent of lenders and 46 per cent of brokers are worried about the new rules.

More specifically, 50 per cent of brokers believe that more mortgage applications will be declined as a result of the new stress tests. Only 14 per cent of lenders believe that will be the case, while another 43 per cent believe that the stress tests may lead to more applications being refused (See Chart 1).

However, the figures show that the percentage of lenders concerned the stress tests will or may have a detrimental effect on applications has increased from 27 per cent in July 2013 to 57 per cent in January 2014. Back in July, 73 per cent believed it would have no significant effect. So why the rise in dread and uncertainty? Perhaps because the FCA has refused to be too prescriptive in setting out the rules on the use of stress tests?

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Scope for variety

It specifies that lenders must “consider the likely future interest rates over a minimum period of five years from the expected start of the loan…” They must be able to justify the basis they use for determining likely future interest rates and they must assume that interest rates will rise by a minimum of 1 per cent over the period. The FCA does not specify how often lenders must review their stress rates or which rate the stress test should be applied to. Also, lenders do not need to make their interest rate assumptions public. Clearly there is plenty of scope for variation in the way that lenders apply the test.

The FCA suggests the forward sterling rate published by the Bank of England as an example of market expectations, but lenders are not bound to use it. In its feedback and final rules on the MMR (PS12/16) it also notes that most lenders currently take account of interest rate rises when assessing affordability, so the decision to compel them to apply a stress test “will not have a significant impact on current market practice”.

While intermediaries’ uncertainty about how adoption of the MMR rules will pan out for their clients is probably understandable, lenders’ uncertainty about their adoption and concern about the stress tests in particular is more worrying. It seems to suggest at the very least that they don’t know what to expect as they take specific approaches to the tests.

Some lenders are taking no chances. One unnamed lender is reported to have said that it will apply the forward sterling rate on the basis it is the only example given by the FCA. It believes that if other lenders rely on other bases it could have a major impact on the market.

So will the stress test have a significant effect or not? Gone are the days of simple income multiples and most lenders will have already built their affordability criteria into their mortgage calculators and are in the process of incorporating the stress tests if they have not already done so.